Part 2 Candle Stick Pattern

Participants in Options Trading

Options markets consist of four main participants:

Buyers of Calls – Expect the underlying asset’s price to rise. Risk limited to premium.

Buyers of Puts – Expect the underlying asset’s price to fall. Risk limited to premium.

Sellers (Writers) of Calls – Expect prices to remain below the strike price. Risk is theoretically unlimited for naked calls.

Sellers (Writers) of Puts – Expect prices to remain above the strike price. Risk is substantial if the asset falls sharply.

Options Strategies

Option trading is highly versatile. Traders can employ strategies ranging from conservative hedging to speculative bets:

Covered Call: Holding the underlying asset while selling call options to generate income from premiums.

Protective Put: Buying puts while holding the asset to protect against downside risk.

Straddle: Buying a call and a put with the same strike price and expiration, expecting high volatility.

Strangle: Buying out-of-the-money call and put options for lower cost but with a wider price movement range.

Spreads: Combining multiple options to limit risk and potential profit (e.g., bull call spread, bear put spread).

Option Pricing Factors

Option prices are influenced by several variables:

Underlying Asset Price: Higher asset prices increase call values and decrease put values.

Strike Price: The proximity of the strike to the current asset price affects intrinsic value.

Time to Expiration: More time increases time value and option price.

Volatility: Greater market volatility increases the likelihood of significant price changes, raising premiums.

Interest Rates & Dividends: Rising interest rates increase call values and reduce put values; dividend payouts impact stock options.

The most widely used pricing model is the Black-Scholes Model, which calculates theoretical option prices based on these factors.

Advantages of Option Trading

Leverage: Control a larger position with a smaller capital outlay.

Hedging: Protect portfolios against adverse price movements.

Flexibility: Execute a wide range of strategies for bullish, bearish, or neutral markets.

Defined Risk: Maximum loss for buyers is limited to the premium paid.

Profit in Any Market: Options allow for profit in rising, falling, or sideways markets.

Risks of Option Trading

Options are complex and involve risks:

Premium Loss: Buyers can lose the entire premium if the option expires worthless.

Leverage Risk: While leverage amplifies gains, it also amplifies losses for sellers or advanced strategies.

Time Decay (Theta): Options lose value as expiration nears if the underlying price does not move favorably.

Volatility Risk (Vega): Changes in market volatility affect option prices.

Complexity: Advanced strategies can involve multiple positions and require careful monitoring.